<PAGE>   1


                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934

For the quarterly period ended September 30, 1998

                                       OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934

For the transition period from _____________________ to ______________________

                         Commission File Number: 0-19594
                                                 -------

                          INSURANCE AUTO AUCTIONS, INC.
                          -----------------------------
             (Exact name of registrant as specified in its charter)

Illinois                                                             95-3790111
-------------------------------------------------------------------------------
(State or other jurisdiction of            (I.R.S. Employer Identification No.)
incorporation or organization)  

850 East Algonquin Road, Suite 100, Schaumburg, Illinois             60173-3855
-------------------------------------------------------------------------------
(Address of principal executive offices)                             (Zip Code)

                                 (847) 839-3939
-------------------------------------------------------------------------------
              (Registrant's telephone number, including area code)


     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.  
                                                                 [X] Yes [ ] No


                      APPLICABLE ONLY TO CORPORATE ISSUERS

Number of shares outstanding of each of the issuer's classes of common stock, as
of September 30, 1998:

               Class                           Outstanding September 30, 1998
               -----                           ------------------------------
    Common Stock, $0.001 Par Value                   11,320,419 shares





<PAGE>   2


                                     INDEX

                          INSURANCE AUTO AUCTIONS, INC.
<TABLE>
<CAPTION>
                                                                   PAGE NUMBER
                                                                   -----------
<S>       <C>                                                          <C>

PART I.   FINANCIAL INFORMATION...................................      3

Item 1.   Financial Statements (Unaudited)........................      3

          Condensed Consolidated Balance Sheets
              as of September 30, 1998 and December 31, 1997......      3
          Condensed Consolidated Statements of Operations 
              for the Three Month and Nine Month Periods ended 
              September 30, 1998 and September 30, 1997...........      4
          Condensed Consolidated Statements of Cash Flows for 
              the Nine Month Periods ended September 30, 1998 
              and September 30, 1997..............................      5
          Notes to Condensed Consolidated Financial Statements....      6

Item 2.   Management's Discussion and Analysis of Financial 
              Condition and Results of Operations.................      7

Item 3.   Quantitative and Qualitative Disclosures 
              about Market Risk...................................     14

PART II.  OTHER INFORMATION.......................................     14

Item 1.   Legal Proceedings.......................................     14

Item 2.   Changes in Securities...................................     14

Item 3.   Defaults upon Senior Securities.........................     14

Item 5.   Other Information.......................................     14

Item 6.   Exhibits and Reports on Form 8-K........................     14

SIGNATURES    ....................................................     15

</TABLE>


                                       2

<PAGE>   3

                         INSURANCE AUTO AUCTIONS, INC.
                                AND SUBSIDIARIES
                     CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
                                             September 30,        December 31,
                                                  1998               1997
                                                  ----               ----
                                              (Unaudited)
ASSETS
<S>                                           <C>                 <C>
Current assets:
  Cash and cash equivalents                   $ 10,407,000        $  9,634,000
  Accounts receivable, net                      34,472,000          28,992,000
  Inventories                                   10,156,000          11,762,000
  Other current assets                           1,762,000           1,868,000
                                              ------------        ------------
      Total current assets                      56,797,000          52,256,000
                                              ------------        ------------
                                                                  
Property and equipment, at                                        
  cost, net                                     21,510,000          20,778,000
                                                                  
Deferred income taxes                            2,603,000           2,603,000
                                                                  
Other assets, principally                                         
  goodwill, net                                129,866,000         131,435,000
                                              ------------        ------------
                                                                  
                                              $210,776,000        $207,072,000
                                              ============        ============
                                                                  
LIABILITIES AND SHAREHOLDERS' EQUITY                              
                                                                  
Current liabilities:                                              
  Current installments of                                         
    long-term debt                            $    200,000        $  2,034,000
  Accounts payable                              17,981,000          16,319,000
  Accrued liabilities                            5,998,000           7,698,000
  Income taxes                                   1,208,000             497,000
                                              ------------        ------------
      Total current liabilities                 25,387,000          26,548,000
                                              ------------        ------------
                                                                  
Long-term debt, excluding                                         
  current installments                          20,161,000          20,246,000
Accumulated postretirement                                        
  benefit obligation                             3,570,000           3,831,000
Deferred income taxes                            5,235,000           5,235,000
                                              ------------        ------------
                                                                  
      Total liabilities                         54,353,000          55,860,000
                                              ------------        ------------
                                                                  
Shareholders' equity:                                             
Preferred stock, par value of                                     
  $.001 per share.                                                
  Authorized 5,000,000 shares;                                    
  none issued.                                           -                   -
Common stock, par value of                                        
  $.001 per share                                                 
  Authorized 20,000,000 shares;                                   
    issued and outstanding 11,320,419                             
    and 11,299,561 shares as of                                   
    September 30, 1998 and December                               
    31, 1997, respectively                          11,000              11,000
Additional paid-in capital                     132,091,000         131,809,000
Retained earnings                               24,321,000          19,392,000
                                              ------------        ------------
                                                                  
      Total shareholders' equity               156,423,000         151,212,000
                                              ------------        ------------
                                                                  
                                              $210,776,000        $207,072,000
                                              ============        ============
</TABLE>

See accompanying notes to condensed consolidated financial statements


                                       3


<PAGE>   4


                          INSURANCE AUTO AUCTIONS, INC.
                                AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                 Three Month Periods            Nine Month Periods
                                                 Ended September 30,            Ended September 30,
                                                 -------------------            -------------------
                                                    (Unaudited)                     (Unaudited)
                                                 1998           1997            1998            1997
                                                 ----           ----            ----            ----
<S>                                        <C>             <C>             <C>             <C>
Net Sales:
     Vehicle sales                         $  45,726,000   $  42,095,000   $ 144,789,000   $ 132,241,000
     Fee income                               24,321,000      19,308,000      69,216,000      63,025,000
                                           -------------   -------------   -------------   -------------
                                              70,047,000      61,403,000     214,005,000     195,266,000
Cost and expenses:                                                                         
     Cost of sales                            53,265,000      47,114,000     161,731,000     150,850,000
     Direct operating expenses                12,650,000      10,887,000      37,779,000      33,766,000
     Amortization of acquisition costs           935,000         945,000       2,833,000       2,840,000
     Special charges                                   -               -       1,564,000         750,000
                                           -------------   -------------   -------------   -------------

         Earnings from operations              3,197,000       2,457,000      10,098,000       7,060,000

Other (income) expense:
     Interest expense                            496,000         668,000       1,560,000       2,073,000
     Interest (income)                          (193,000)       (210,000)       (589,000)       (609,000)
                                           -------------   -------------   -------------   -------------
                                                                                           
         Earnings before income taxes          2,894,000       1,999,000       9,127,000       5,596,000
                                                                                           
Income taxes                                   1,331,000       1,028,000       4,198,000       2,575,000
                                           -------------   -------------   -------------   -------------
                                                                                           
         Net earnings                      $   1,563,000   $     971,000   $   4,929,000   $   3,021,000
                                           =============   =============   =============   =============
                                                                                           
Earnings per share:                                                                        
     Basic                                 $         .14   $         .09   $         .44   $         .27
                                           =============   =============   =============   =============
     Diluted                               $         .14   $         .09   $         .43   $         .27
                                           =============   =============   =============   =============
                                                           
Weighted average shares outstanding:                       
     Basic                                    11,320,000      11,298,000      11,313,000      11,293,000
                                           =============   =============   =============   =============
     Diluted                                  11,474,000      11,373,000      11,432,000      11,318,000
                                           =============   =============   =============   =============
</TABLE>

See accompanying notes to condensed consolidated financial statements.



                                       4


<PAGE>   5


                         INSURANCE AUTO AUCTIONS, INC.
                                AND SUBSIDIARIES
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (UNAUDITED)
<TABLE>
<CAPTION>
                                                         Nine Month Periods
                                                         Ended September 30, 
                                                      -------------------------
                                                          1998         1997
                                                          ----         ----
<S>                                                   <C>           <C>
Cash flows from operating activities:
Net earnings                                          $ 4,929,000   $ 3,021,000
   Adjustments to reconcile net earnings to net cash                
       provided by operating activities:                            
           Depreciation and amortization                6,539,000     5,930,000
           Loss on disposal of fixed assets                79,000             0
   Change in assets and liabilities (net of                         
     effects of acquired companies):                                
       (Increase) decrease in:                                      
           Accounts receivable, net                    (5,042,000)    4,009,000
           Inventories                                  1,606,000      (859,000)
           Other current assets                           106,000     1,350,000
           Other assets                                    56,000      (188,000)
       Increase (decrease) in:                                      
           Accounts payable                             1,662,000       824,000
           Accrued liabilities                         (1,852,000)   (2,136,000)
           Income taxes payable                           711,000       948,000
                                                      -----------   -----------
           Total adjustments                            3,865,000     9,878,000
                                                      -----------   -----------
                                                                    
     Net cash provided by operating activities          8,794,000    12,899,000
                                                      -----------   -----------
                                                                    
Cash flows from investing activities:                               
   Proceeds from disposal of fixed assets                  22,000             0
   Capital expenditures                                (4,338,000)   (2,501,000)
   Payments made in connection with                                 
     acquired companies,                               (1,806,000)     (196,000)
                                                      -----------   -----------
      net of cash acquired                                          
                                                                    
      Net cash used in investing activities            (6,122,000)   (2,697,000)
                                                      -----------   -----------
                                                                    
Cash flows from financing activities:                               
   Payment of line of credit and  notes                             
     payable to acquired companies                     (2,180,000)   (2,541,000)
   Net proceeds (payment) of line of                                
     credit and notes payable                          (4,657,000)  
   Proceeds from issuance of common stock                 282,000        90,000
                                                      -----------   -----------
                                                                    
Net cash provided by (used in) financing activities     1,898,000    (7,108,000)
                                                      -----------   -----------
                                                                    
Net increase in cash                                      773,000     3,094,000
                                                                    
Cash and cash equivalents at beginning of period        9,634,000     5,888,000
                                                      -----------   -----------
                                                                    
Cash and cash equivalents at end of period            $10,407,000   $ 8,982,000
                                                      ===========   ===========
                                                                    
Supplemental disclosures of cash flow information:                  
  Cash paid during the year for:                                    
     Interest                                         $ 1,793,000   $ 4,205,000
     Income taxes                                       3,500,000     1,627,000
                                                      ===========   ===========

</TABLE>

See accompanying notes to condensed consolidated financial statements.



                                       5


<PAGE>   6


                         INSURANCE AUTO AUCTIONS, INC.
                                AND SUBSIDIARIES
                                        
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (UNAUDITED)
1.     GENERAL

       The unaudited condensed consolidated financial statements of Insurance
       Auto Auctions, Inc. and its subsidiaries (collectively, the "Company")
       have been prepared on the same basis as the audited consolidated
       financial statements and, in the opinion of the Company, reflect all
       adjustments (consisting of normal recurring adjustments) necessary for a
       fair presentation for each of the periods presented. The results of
       operations for interim periods are not necessarily indicative of results
       for full fiscal years.

       As contemplated by the Securities and Exchange Commission ("SEC") under
       Rule 10-01 of Regulation S-X, the accompanying consolidated financial
       statements and related notes have been condensed and do not contain
       certain information that will be included in the Company's annual
       consolidated financial statements and notes thereto. For further
       information, refer to the consolidated financial statements and notes
       thereto included in the Company's annual report on Form 10-K for the year
       ended December 31, 1997

2.     INCOME TAXES

       Income taxes were computed using the effective tax rate estimated to be
       applicable for the full fiscal year, which is subject to ongoing review
       and evaluation by the Company.

3.     NET EARNINGS PER SHARE

       Reconciliations of the numerators and denominators of the basic and
       diluted earnings per share computations for the three months and nine
       months ended September 30, 1998 and 1997 are as follows:

<TABLE>
<CAPTION>

                                Three Month Period Ended September 30, 1998   Three Month Period Ended September 30, 1998
                                -------------------------------------------   -------------------------------------------
                                                                 Per Share                                     Per Share
                                  Earnings         Shares         Amount         Earnings         Shares        Amount
                                  --------         ------         ------         --------         ------        ------
<S>                              <C>             <C>              <C>          <C>              <C>              <C>
Basic Earnings per Share
     Net earnings                $1,563,000      11,320,000       $0.14        $  971,000       11,298,000       $0.09
                                                                  =====                                          =====
Effect of Dilutive Securities
     Stock options                        -         154,000                             -           75,000
                                 ==========      ==========       =====        ==========       ==========       =====
                       
Diluted Earnings per Share
     Income available to
     common stockholders
     plus assumed conversions    $1,563,000      11,474,000       $0.14        $  971,000       11,373,000       $0.09
                                 ==========      ==========       =====        ==========       ==========       =====

                                Nine Month Period Ended September 30, 1998    Nine Month Period Ended September 30, 1997
                                ------------------------------------------    ------------------------------------------
                                                                 Per Share                                     Per Share
                                  Earnings         Shares         Amount         Earnings         Shares        Amount
                                  --------         ------         ------         --------         ------        ------
Basic Earnings per Share 
     Net earnings                $4,929,000      11,313,000       $0.44        $3,021,000       11,293,000       $0.27     
                                                                  =====                                          =====

Effect of Dilutive Securities
     Stock options                        -         119,000                             -           25,000
                                 ==========      ==========       =====        ==========       ==========       =====

Diluted Earnings per Share
     Income available to
     common stockholders
     plus assumed conversions    $4,929,000      11,432,000       $0.43        $3,021,000       11,318,000       $0.27
                                 ==========      ==========       =====        ==========       ==========       =====

</TABLE>

                                       6




<PAGE>   7


4.     COMPREHENSIVE INCOME

       In June 1997, the Financial Accounting Standards Board issued Statement
       of Financial Accounting Standards No. 130, "Reporting Comprehensive
       Income" ("SFAS 130"). SFAS 130 establishes standards for reporting and
       display of comprehensive income and its components in a full set of
       general-purpose financial statements. SFAS 130 is effective for financial
       statements for fiscal years beginning after December 15, 1997 and was
       adopted by the Company in the three months ended March 31, 1998. Adoption
       of SFAS 130 did not have a material impact on the Company's consolidated
       financial position, results of operations, or liquidity.


5.     SPECIAL CHARGES

       During the first quarter of 1998, a settlement agreement was entered into
       by the Company resolving all outstanding differences between Insurance
       Auto Auctions, Inc. and Bradley Scott, who has resigned as a director and
       Chairman of the Board. In the settlement agreement, various agreements
       were terminated (including agreements providing for compensation and
       certain benefits through June 30, 1999, and all outstanding stock
       options). Per the settlement agreement, the Company made a lump-sum
       payment of $700,000 to Scott. This included a bonus payment for 1997 of
       $126,000 pursuant to a 1996 agreement between the Company and Scott. The
       difference of $574,000 was recorded as a special charge in first quarter
       1998. In addition, McKinsey & Co. had been retained to assist the Company
       in identifying and developing additional customer-valued services,
       focusing on opportunities to add value to the insurance industry's
       automobile claims process and reduce costs for these organizations. The
       scope of the work completed also included the evaluation and development
       of new business offerings that leverage the company's current
       competencies, geographic presence and assets. The cost of the project of
       $990,000 was recorded as a special charge in first quarter 1998.

       During the second quarter of 1997, the Company settled a securities class
       action lawsuit that had been pending against the Company and certain of
       its present and former officers and directors, in the United States
       District Court for the Central District of California. The litigation was
       settled for $3.75 million, the substantial portion of which was paid by
       the Company's directors' and officers' liability insurance company. The
       difference of $750,000 was recognized as a special charge to earnings in
       the second quarter of 1997. In February 1998, the settlement was approved
       by the court.



ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

The discussion in this section contains forward-looking information that is
subject to certain risks, trends and uncertainties that could cause actual
results to differ materially from those projected, expressed or implied by such
forward looking information. The Company's actual results could differ
materially from those discussed herein. Factors that could cause or contribute
to such differences include, but are not limited to, those discussed in "Factors
That May Affect Future Results" below. Among these risks are quality and
quantity of inventory available from suppliers, competition, dependence on key
insurance company suppliers, governmental regulation, weather conditions and
market value of salvage.


OVERVIEW

     The Company offers insurance companies and other vehicle suppliers
cost-effective salvage processing solutions through a variety of different
methods of sale, including fixed fee consignment, purchase agreement and
percentage of sale consignment. Under the purchase agreement sales method, the
vehicle is owned by the Company and the sales price of the vehicle is recorded
in revenue. Under the fixed fee and percentage of sale consignment sales
methods, the vehicle is not owned by the Company and only the fees associated
with the processing and sale of the vehicle are recorded in net sales. 



                                       7




<PAGE>   8

By assuming some of the risk inherent in owning the salvage vehicle instead of
selling on a consignment basis, the Company is potentially able to increase
profits by improving the value of the salvage vehicle prior to the sale.

     Under the purchase agreement method, IAA generally pays the insurance
company a pre-determined percentage of the Actual Cash Value ("ACV") to purchase
the vehicle, pursuant to a purchase agreement. ACV's are the estimated
pre-accident fair value of a vehicle, adjusted for additional equipment, mileage
and other factors. Because the Company's purchase price is fixed by contract,
changes in ACV's or in the market or auction prices for salvage vehicles have an
impact on the profitability of the sale of vehicles under the purchase agreement
method. If increases in used car prices and ACV's are not associated with a
corresponding increase in prices at salvage auctions, there can be a negative
impact on the profitability of purchase agreement sales.

     The Company has adjustment and risk-sharing clauses in its standard
purchase agreement contracts designed to provide protection to the Company and
its customers from certain unexpected, significant changes in the ACV/salvage
price relationship. The Company has renegotiated or terminated all significant
purchase agreement contracts not conforming to the Company's standards for this
type of agreement, converting customers to either a fixed fee consignment or
percent of sale consignment contract whenever possible. However, the Company
continues to offer purchase agreements to those customers who select it.

     Since its initial public offering, the Company has grown primarily through
a series of acquisitions to now include 49 locations as of September 30, 1998.
In February of 1998, the Company acquired Auto Disposal Company ("ADC"). ADC
operated two pools in Alabama. In October of 1998, the Company opened a new
greenfield location in Bay Point, California.

     The Company's operating results are subject to fluctuations, including
quarterly fluctuations, that can result from a number of factors, some of which
are more significant for sales under the purchase agreement method. See "Factors
That May Affect Future Results" below for a further discussion of some of the
factors that affect or could affect the Company's business, operating results
and financial condition.


RESULTS OF OPERATIONS

Three Months Ended September 30, 1998 Compared to the Three Months Ended
September 30, 1997

     Net sales of the Company increased to $70,047,000 for the three months
ended September 30, 1998, from $61,403,000 for the same three month period in
1997. Unit volume increased 13%, compared to the same period in 1997. The volume
increase is primarily the result of an increase in same store sales. The
purchase agreement sales method of processing accounted for 30% of total volume,
consistent with the same period in 1997.

     Gross profit increased 17% to $16,782,000 for the three months ended
September 30, 1998, from $14,289,000 for the same period in 1997. Gross profit
per unit of $146 for the three months ended September 30, 1998 was 4% higher
than for the comparable period of 1997. The Company experienced a positive
impact on margins during this period as a result of its continuing focus on
increasing profitability by insuring its services are properly valued in the
market place. However, at the same time, margins were negatively impacted by a
decline in the marketplace of actual cash values and selling prices, traditional
seasonal changes in the quality of salvage, and a decline of the price of scrap
steel to a thirty year low, which decreased the selling prices of the Company's
older car inventory.

     Direct operating expenses increased to $12,650,000 for the three months
ended September 30, 1998, from $10,887,000 for the same period in 1997. Direct
operating expenses per unit increased to $110 for the three months ended
September 30, 1998, as compared to $107 for the same period in 1997. The
increase reflects the funding commitment made for the piloting of several
value-added services that will 


                                       8


<PAGE>   9


streamline the automobile claims process, resulting in reduced costs for
insurance companies and the acquisition of the two locations in Alabama.

     Amortization of acquisition costs of $935,000 for the three months ended
September 30, 1998 were relatively flat as compared to $945,000 for the
comparable period in 1997.

     Interest expense decreased to $496,000 for the three months ended September
30, 1998, from $668,000 for the same period in 1997. The change in interest
expense was attributable to a decrease in long-term debt as a result of the
Company's repayment of several notes payable to sellers related to certain
acquisitions. Interest income decreased to $193,000 for the three month period
ended September 30, 1998, from $ 210,000 for the comparable period in 1997.

     Income taxes increased to $1,331,000 for the three months ended September
30, 1998, from $1,028,000 for the comparable period in 1997. This increase is
the result of the increase in earnings. The Company's effective tax rate for the
three months ended September 30, 1998 was 46%. The effective tax rate is subject
to ongoing review and evaluation by the Company.

     The Company's net earnings were $1,563,000 for the three months
ended September 30, 1998, a 61% increase from $971,000 for the comparable period
in 1997.


Nine Months Ended September 30, 1998 Compared to the Nine Months Ended September
30, 1997

     Net sales of the Company increased to $214,005,000 for the nine months
ended September 30, 1998, from $195,266,000 for the same Nine month period in
1997, a 10% increase. Unit volume for the nine months ended September 30, 1998,
was 345,000, as compared to 333,000 for the same period in 1997. The increase in
volume is the result of an increase in same store sales from the prior period
and the acquisition of the two locations in Alabama. The purchase agreement
sales method of processing accounted for 30% of total volume, compared with 31%
for the same period in 1997.

     Gross profit increased to $52,274,000 for the nine months ended September
30, 1998, from $44,416,000 for the same period in 1997, an 18% increase. Gross
profit per unit of $152 for the nine months ended September 30, 1998 was 14%
higher than for the comparable period of 1997.

     Direct operating expenses increased to $37,779,000 for the nine months
ended September 30, 1998, from $33,766,000 in 1997, a 12% increase. The increase
reflects a general increase in operating expenses, the funding commitment made
by the Company to identify, develop and pilot new services that will streamline
the automobile claims process, resulting in reduced costs for insurance
companies, and the acquisition of two locations in Alabama.

     Amortization of acquisition costs decreased slightly to $2,833,000 for the
nine month period ended September 30, 1998 from $2,840,000 for the comparable
period in 1997.

     During the first quarter of 1998, a settlement agreement was entered into
by the Company resolving all outstanding differences between Insurance Auto
Auctions, Inc. and Bradley Scott, who has resigned as a director and Chairman of
the Board. In the settlement agreement, various agreements were terminated
(including agreements providing for compensation and certain benefits through
September 30, 1999, and all outstanding stock options). Per the settlement
agreement, the Company made a lump-sum payment of $700,000 to Scott. This
included a bonus payment for 1997 of $126,000 pursuant to a 1996 agreement
between the Company and Scott. The difference of $574,000 was recorded as a
special charge in first quarter 1998.

     McKinsey & Co. had been retained to assist the Company in identifying and
developing additional customer-valued services, focusing on opportunities to add
value to the insurance industry's automobile claims process and reduce costs for
these organizations. The scope of the work completed also



                                       9


<PAGE>   10

included the evaluation and development of new business offerings that leverage
the company's current competencies, geographic presence and assets. The cost of
the project of $990,000 was recorded as a special charge in first quarter 1998.

     Interest expense decreased to $1,560,000 for the nine months ended
September 30, 1998, from $2,073,000 for the same period in 1997. The change in
interest expense was mostly attributable to a decrease in long-term debt as a
result of the Company's repayment of the proceeds of several notes payable to
sellers related to certain acquisitions.

     Interest income was $589,000 for the nine month period ended September 30,
1998, versus $609,000 for the comparable period in 1997.

     Income taxes increased to $4,198,000 for the nine months ended September
30, 1998, from $2,575,000 for the comparable period in 1997. This increase is
the result of the increase in earnings. The Company's effective tax rate for the
nine months ended September 30, 1998 was 46%. The effective tax rate is subject
to ongoing review and evaluation by Management.

     The Company's net earnings were $4,929,000 for the nine months ended
September 30, 1997, a 63% increase from the comparable period in 1997 of
$3,021,000. Net earnings per diluted common share increased to 43 cents per
share in 1998 versus 27 cents per share in 1997. Net earnings excluding the
special charge were $5,774,000, or 51 cents per share, for the first nine months
of 1998.


FINANCIAL CONDITION AND LIQUIDITY

     At September 30, 1998, the Company had current assets of $56,797,000,
including $10,407,000 of cash and cash equivalents and current liabilities of
$25,387,000. The Company had working capital of $31,410,000 at September 30,
1998, a $5,702,000 increase from December 31, 1997.

     At September 30, 1998, the Company's indebtedness consisted mostly of 8.6%
Senior Notes approximating $20,000,000. There were no borrowings outstanding on
the Revolving Line of Credit Facility at September 30, 1998.

     Capital expenditures were approximately $4,338,000 for the nine months
ended September 30, 1998. These capital expenditures primarily included
upgrading and expanding the Company's management information system and the
Company's facilities. The Company currently leases most of its facilities and
other properties.

     The Company believes that cash generated from operations and its borrowing
capacity will be sufficient to fund capital expenditures and provide adequate
working capital for operations for the next twelve months. Part of the Company's
plan is continued growth, possibly through new facility start-ups, acquisitions,
and the development of new claims processing services. At some time in the
future, the Company may require additional financing. There can be no assurance
that additional financing, if required, will be available on favorable terms.

     The Company's operating results have not historically been materially
affected by inflation.


RECENT DEVELOPMENTS

     Statement of Financial Accounting Standards ("S.F.A.S.") No. 131,
"Disclosures about Segments of an Enterprise and Related Information", was
issued in September 1997 and is effective for fiscal years beginning after
December 15, 1997. S.F.A.S. No. 131 establishes new standards for disclosing
information about operating segments. Adoption of this statement did not have a
material impact on the Company's financial position, results of operations, or
liquidity.




                                       10



<PAGE>   11

     In February 1998, the FASB issued Statement of Financial Accounting
Standards No. 132, "Employers' Disclosures about Pensions and Others
Postretirement Benefits" ("SFAS 132") which amends the disclosure requirements
of SFAS No. 87, "Employers' Accounting for Pensions", SFAS No. 88, "Employers'
Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and
for Termination Benefits", SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions." SFAS No. 132 is effective for
fiscal years beginning after December 15, 1997. Adoption of this statement did
not have a material impact on the Company's financial position, results of
operations, or liquidity.

     The Company undertook an initiative, ("the Project"), in mid 1997, the
objective of which is to determine and assess the risks of the Year 2000 issue,
and plan and institute mitigating actions to minimize those risks. The Project
team is being led by the Company's Vice President - Information Systems. The
scope of the Project includes both IT based systems and non IT systems.
Modifications required to bring the Company's IT systems into Year 2000
compliance were identified by the Project team. Those modifications have been
completed and implemented. Based on the findings of the Project team and the
successful implementation of these required modifications, the Company believes
its IT based systems are currently Year 2000 compliant in all material respects.
Based on work completed by the Project team, the Company believes its non IT
system Year 2000 compliance issues do not represent a significant risk to the
Company.

     The Company may be impacted by the effect the year 2000 issue has on the
ability of the Company's Insurance customers to process automobile claims and
state Departments of Motor Vehicles ("DMV's") to process titles on a timely
basis. Any delay in the timely processing of automobile claims that
significantly reduces the number of units the Company has available for sale
would have a material adverse affect on the Company's financial position,
results of operations or liquidity. In addition, the Company relies on state
DMV's to timely process titles to vehicles. Because the Company must generally
obtain title prior to selling a vehicle, a significant delay in title processing
would result in the Company's ability to sell vehicles from inventory and have a
material adverse impact on the company's financial position, results of
operations or liquidity.

     The Company has been, and will continue to be, in communication with
its principal insurance customers and the DMV's with regard to their year 2000
readiness. None of the responses received to date suggests there will be any
interruption in their operations which would have a material adverse impact on
the Company although there can be no assurances given in this manner. Formal
contingency plans will be developed by March 31, 1999.

     The cost to the Company of dealing with the Year 2000 issue is not expected
to be material. Although a portion of the time of IT personnel and related
management has been and will be employed in evaluating the problem, taking
corrective actions and preparing contingency plans, the Company does not believe
other IT projects or operations have been or will be adversely affected. Costs
of review, analysis and corrective action are expected to total less than
$100,000.

     Effective December 1, 1993, the Company entered into a national sales
agreement with Allstate Insurance Company ("Allstate") that, as subsequently
modified, established the Company as Allstate's preferred provider of salvage
processing services. The Company agreed to purchase salvage and theft recovered
vehicles from Allstate, or sell such vehicles on behalf of Allstate, in various
geographic markets throughout the Country. Local Allstate management is
responsible for deciding who will be the provider of automotive salvage services
for their geographic area of responsibility. The national agreement provides
specific guidelines as to the general terms and structure to which any local
agreement must conform. These agreements typically have terms of one or two
years, but are generally subject to termination by either party upon 30 days
notice. For the fiscal year ended December 31, 1997, vehicles purchased from, or
sold on behalf of, Allstate accounted for approximately 17% of the Company's
total unit sales, making Allstate the Company's second largest supplier of
vehicles for auction.



                                       11



<PAGE>   12

     Allstate has recently invited the Company to submit a proposal to provide
automobile salvage services for Allstate locations across the country, effective
January 1, 1999. The Company understands that Allstate has requested this
proposal as part of a comprehensive review of Allstate's automobile salvage
disposition practices. The Company is working aggressively to maintain and
increase the amount of business it receives from Allstate and to maintain the
profitability of that business. However, no assurance can be given as to the
results of Allstate's review, and the Company may receive less, or less
profitable, business from Allstate than it currently does. A significant
reduction of Allstate business, or a significant reduction in the profitability
of that business, would have a material adverse affect or could affect the
Company's business, operating results and financial condition.


FACTORS THAT MAY AFFECT FUTURE RESULTS

     The Company operates in a changing environment that involves a number of
risks, some of which are beyond the Company's control. The following discussion
highlights some of these risks.

     Quarterly Fluctuations. The Company's operating results have in the past
and may in the future fluctuate significantly depending on a number of factors,
some of which are more significant for sales under the purchase agreement
method. These factors include changes in the market value of salvage vehicles,
attendance at salvage auctions, delays or changes in state title processing,
fluctuations in Actual Cash Values ("ACV's") of salvage vehicles, changes in
regulations governing the processing of salvage vehicles, general weather
conditions and the availability and quality of salvage vehicles. The Company is
also dependent upon receiving a sufficient number of total loss vehicles as well
as recovered theft vehicles to sustain its profit margins. Factors which can
affect the number of vehicles received include (a) reduction of policy writing
by insurance providers which would affect the number of claims over a period of
time and (b) changes in direct repair procedures that would reduce the number of
newer less damaged total loss vehicles that tend to have the higher salvage
values. Additionally in the last few years there has been a declining trend in
theft occurrences. As a result, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as any indication of future performance. In addition,
revenues for any future quarter are not predictable with any significant degree
of accuracy; while the Company's operating expense levels do not vary
significantly with changes in volume. If revenue levels are below expectations,
operating results are likely to be adversely affected. Due to all of the
foregoing factors, it is likely that in some future quarters the Company's
operating results will be below the expectations of public market analysts and
investors.

     Quality and Quantity of Inventory Available from Suppliers. The Company is
dependent upon receiving a sufficient number of total loss vehicles as well as
recovered theft vehicles to sustain its profit margins. Factors which can affect
the number of salvage vehicles received include reduction of policy writing by
insurance providers which would affect the number of claims over a period of
time, the changes in direct repair procedures that would reduce the number of
newer less damaged total loss vehicles that tend to have higher salvage values
and general weather conditions. For example, a comparatively mild winter can
result in fewer "total loss" accidents, causing fewer vehicles to be available
for sale by the Company. The decreases in the quality and quantity of inventory
and in particular the availability of newer and less damaged vehicles are
further aggravated under the purchase agreement method of salvage and can have a
negative impact on the operating results and financial condition of the Company.

     Competition. Historically, the automotive salvage industry has been highly
fragmented. As a result, the Company faces intense competition for the supply of
salvage vehicles from vehicle suppliers, as well as competition from processors
of vehicles from other regional salvage pools. These regional salvage pools
generally process vehicles under the fixed fee consignment method and generally
do not offer the full range of services provided by the Company. The salvage
industry has recently experienced consolidation, however, and the Company
believes its principal publicly-held competitor is Copart, Inc. Copart, Inc. has
effected a number of acquisitions of regional salvage pools and competes with
IAA in most of IAA's geographic markets. Due to the limited number of vehicle
suppliers, competition for salvage vehicles from Copart and regional suppliers
is intense. It is also possible that the Company may encounter further



                                       12



<PAGE>   13


competition from existing competitors and new market entrants that are
significantly larger and have greater financial and marketing resources. Other
potential competitors could include used car auction companies, providers of
claims software to insurance companies, certain salvage buyer groups and
insurance companies, some of which presently supply auto salvage to IAA. While
most insurance companies have abandoned or reduced efforts to sell salvage
without the use of service providers such as the Company, they may in the future
decide to dispose of their salvage directly to customers. There can be no
assurance that the Company will be able to compete successfully against current
or future competitors or that competitive pressures faced by the Company will
not have a material adverse effect on its business, operating results and
financial condition.

     Dependence on Key Insurance Company Suppliers. Historically, a
limited number of insurance companies have accounted for a substantial portion
of the Company's revenues. For example, in 1997, vehicles supplied by the
Company's three largest suppliers accounted for approximately 46% of the
Company's unit sales. The largest suppliers, State Farm Insurance, Allstate
Insurance ("Allstate"), and Farmers Insurance, each accounted for approximately
19%, 17%, and 10%, respectively, of the Company's unit sales. A number of other
insurance company suppliers, including 20th Century Insurance, have also
contributed to the profitability of the Company. A loss or reduction in the
number of vehicles from any of these suppliers, or adverse change in the
agreements that such suppliers have with the Company, could have a material
adverse effect on the Company's business, operating results and financial
condition.

     Purchase Agreement Method of Sale. The Company has entered into a number of
purchase agreements, including agreements with its most significant insurance
suppliers, that obligate the Company to purchase most salvage vehicles offered
to it at a formula percentage of ACV. Increases in ACV's associated with flat or
declining market or auction prices for salvage vehicles could have a material
adverse effect on the Company's business, operating results and financial
condition. The Company has adjustment and risk-sharing clauses in its standard
purchase agreement contracts designed to provide some protection to the Company
and its customers from certain unexpected, significant changes in the
ACV/salvage price relationship.

     Governmental Regulation. The Company's operations are subject to
regulation, supervision and licensing under various federal, state and local
statutes, ordinances and regulations. The acquisition and sale of totaled and
recovered theft vehicles is regulated by state motor vehicle departments in each
of the locations in which the Company operates. Changes in governmental
regulations or interpretations of existing regulations can result in increased
costs, reduced salvage vehicle prices and decreased profitability for the
Company. In addition to the regulation of sales and acquisitions of vehicles,
the Company is also subject to various local zoning requirements with regard to
the location of its auction and storage facilities. These zoning requirements
vary from location to location. Failure to comply with present or future
regulations or changes in existing regulations could have a material adverse
effect of the Company's business, operating results and financial condition.

     Provision of Services as a National or Regional Supplier. The provision of
services to insurance company suppliers on a national or regional basis require
that the Company expends resources and dedicate management to a small number of
individual accounts, resulting in a significant amount of fixed costs. The
development of a referral based national network service, in particular, has
required the devotion of financial resources without immediate reimbursement of
such expenses by the insurance company suppliers.

     Integration and Expansion of Facilities. The Company seeks to increase
sales and profitability through acquisition of other salvage auction facilities,
new site expansion and the increase of salvage vehicle volume at existing
facilities. There can be no assurance that the Company will continue to acquire
new facilities on terms economical to the Company or that the Company will be
able to add additional facilities on terms economical to the Company or that the
Company will be able to increase revenues at newly acquired facilities above
levels realized prior to acquisition. The Company's ability to achieve these
objectives is dependent, among other things, on the integration of new
facilities, and their information systems, into its existing operations, the
identification and lease of suitable premises and the availability of 



                                       13



<PAGE>   14


capital. There can be no assurance that this integration will occur, that
suitable premises will be identified or that additional capital will be
available to fund expansion and integration of the Company's business. Any
delays or obstacles in this integration process could have a material adverse
effect on the Company's business, operating results and financial condition.
Furthermore, the Company has limited sources of additional capital available for
acquisitions, expansions and start-ups. The Company's ability to integrate and
expand its facilities will depend on its ability to identify and obtain
additional sources of capital to finance such integration and expansion. In the
future, the Company will be required to continue to improve its financial and
management controls, reporting systems and procedures on a timely basis and
expand, train and manage its employee work force. The failure to improve these
systems on a timely basis and to successfully expand and train the Company's
work force could have a material adverse effect on the Company's business,
operating results and financial condition.

     Volatility of Stock Price. The market price of the Company's common stock
has been and could continue to be subject to significant fluctuations in
response to various factors and events, including variations in the Company's
operating results, the timing and size of acquisitions and facility openings,
the loss of vehicle suppliers or buyers, the announcement of new vehicle supply
agreements by the Company or its competitors, changes in regulations governing
the Company's operations or its vehicle suppliers, environmental problems or
litigation.

     Environmental Regulation. The Company's operations are subject to federal,
state and local laws and regulations regarding the protection of the
environment. In the salvage vehicle auction industry, large numbers of wrecked
vehicles are stored at auction facilities for short periods of time. Minor
spills of gasoline, motor oils and other fluids may occur from time to time at
the Company's facilities and may result in soil, surface water or groundwater
contamination. Petroleum products and other hazardous materials are contained in
aboveground or underground storage tanks located at certain of the Company's
facilities. Waste materials such as waste solvents or used oils are generated at
some of the Company's facilities and are disposed of as nonhazardous or
hazardous wastes. The Company believes that it is in compliance in all material
respects with applicable environmental regulations and does not anticipate any
material capital expenditure for environmental compliance or remediation.
Environmental laws and regulations, however, could become more stringent over
time and there can be no assurance that the Company or its operations will not
be subject to significant compliance costs in the future. To date, the Company
has not incurred expenditures for preventive or remedial action with respect to
contamination or the use of hazardous materials that have had a material adverse
effect on the Company's results of operations or financial condition. The
contamination that could occur at the Company's facilities and the potential
contamination by previous users of certain acquired facilities create the risk,
however, that the Company could incur substantial expenditures for preventive or
remedial action, as well as potential liability arising as a consequence of
hazardous material contamination, which could have a material adverse effect on
the Company.

ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. 
          INAPPLICABLE


PART II.  OTHER INFORMATION.
          ------------------

ITEM 1.   LEGAL PROCEEDINGS. INAPPLICABLE
          ------------------

ITEM 2.   CHANGES IN SECURITIES.  INAPPLICABLE
          ----------------------

ITEM 3.   DEFAULTS UPON SENIOR SECURITIES.  INAPPLICABLE
          --------------------------------

ITEM 4.   SUBMISSION OF MATTERS TO A VOTE ON SECURITY HOLDERS.  INAPPLICABLE
          ----------------------------------------------------

ITEM 5.   OTHER INFORMATION.  INAPPLICABLE
          ------------------

ITEM 6.   EXHIBITS AND REPORTS ON FORM 8-K.
          ---------------------------------

          (a) EXHIBITS.
              ---------

              27.1  Financial Data Schedule



                                       14

<PAGE>   15



                                   SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.


                                   INSURANCE AUTO AUCTIONS, INC.




Date: November 16, 1998            By:    /s/ Linda C. Larrabee 
      -----------------                --------------------------------------
                                   Name:  Linda C. Larrabee
                                   Title: Senior Vice President, 
                                          Chief Financial Officer and Secretary

                                          (Duly Authorized Officer and 
                                               Principal Financial Officer)



                                       15

<PAGE>   16



                                  EXHIBIT INDEX




EXHIBIT NO.
-----------

27.1          Financial Data Schedule







                                       16